SEC Says It Declined to Sue Moody's for Fraud Over Company's Debt Ratings

Moody’s Corp. chose not to revise erroneous debt ratings in 2007 out of concern for the company’s reputation, according to U.S. regulators who declined to sue because they were uncertain of their authority.

A Moody’s Investors Service committee in Europe violated the company’s procedures in declining to correct errors in ratings on constant proportion debt obligations “because of concern that doing so would negatively impact” the firm, the Securities and Exchange Commission said in a report today.

“Because of uncertainty regarding a jurisdictional nexus between the United States and the relevant ratings conduct, the Commission declined to pursue a fraud enforcement action,” the SEC said in the report, which noted that the agency’s authority has been clarified by the Dodd-Frank financial-regulation law.

Ratings companies Moody’s, McGraw-Hill Cos. Standard & Poor’s unit and Fitch faced scrutiny from Congress and state regulators after they assigned top marks to U.S. subprime- mortgage bonds before that market collapsed in 2007. The ensuing credit crisis resulted in $1.8 trillion in writedowns from financial firms worldwide, according to Bloomberg data.

The ratings of about 11 CPDO issuers that were marketed in Europe by Moody’s were higher than they should have been because of a coding error, according to the SEC report. The notes had a combined value of almost $1 billion, the agency said.

“In this particular case we seem to face an important reputation risk issue,” a Moody’s rating committee member said in a Jan. 24, 2007, e-mail cited in the SEC report. The issue “is so important that I would feel inclined at this stage to minimize ratings impact” rather than “even allow for the possibility of a hint that the model has a bug,” the e-mail said.

Company Comment

“We fully support the Commission’s message that every rating decision must be based only on credit considerations, and we are committed to maintaining robust procedures to ensure that our internal company policies are followed,” Moody’s spokesman Michael Adler said today in an interview.

CPDOs sell contracts based on indexes of credit-default swaps, contracts conceived to protect bondholders against default. The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements.

The Dodd-Frank law empowers the SEC to bring fraud lawsuits when the conduct includes significant steps or substantial effect within the U.S., the SEC said.

To contact the reporter on this story: Joshua Gallu in Washington at jgallu@bloomberg.net